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Debit Spreads vs Credit Spreads

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by Gavin in Blog
February 25, 2020 2 comments

Debit spreads vs credit spreads are trading strategies that involves buying and selling options with a different strike price but the same expiration date.

A debit spread is named as such since the trading account’s balance is reduced as the total value of the options bought is higher than the premium earned on the options sold.

On the other hand, a credit spread generates a money inflow since the premium collected from the options sold is higher than the cost of the options bought.

Both strategies can have bullish and bearish approaches and here I’ll explain how each of them works.

Debit Spread Strategies

Bull Call Spread

A bull call spread strategy consists of buying a certain call option with a given strike price and selling another call option of the same underlying asset with a higher strike price in the same expiration period.

As a result, the trading account is debited.

In this case, the trader is expecting that the price of the underlying asset increases, hence a bullish position, and the maximum profit will be achieved if the price moves beyond the strike price of the call option sold.

Bear Put Spread

A bear put spread is a debit spread strategy that consists of buying a put option with a given strike price while selling another put option with a lower strike price in the same expiration period.

There’s a net debit as a result since the put option with the highest strike price is more expensive than the lower strike price put.

The maximum profit should be realized if the price of the underlying asset drops beyond the strike price of the puts sold.

Credit Spread Strategies

Bear Call Spread

A bear call spread strategy is used when the trader intends to profit from a downward trend.

It consists of selling a certain call option at a given strike price and subsequently buying another call option with a higher strike price in the same expiration period.

The net result is a credit to the trading account as traders as the sold call has a higher price than the call being bought.

The maximum profit occurs if the stock finished below the sold call at expiry. At this point, the profits will be equal to the premium obtained through when the position was opened.

Bull Put Spread

A bull put spread strategy is employed if the trader’s sentiment is neutral to bullish and he expects flat or a mild appreciation in the price of the underlying asset.

The strategy consists of selling a put option generally below the current stock price while buying another put with a lower strike price in the same expiration period.

The bought put will have a lower price than the sold put and as a result the trading account will be credited with the difference.

The maximum profit will be realized if the closing price is higher than the highest strike price (the price of the put option sold). In this case, the entire spread would expire worthless and the trader would have kept the premium income.

debit spreads vs credit spreads

Additional Comments on Debit and Credit Spreads

  • Debit spreads are more appropriate for low IV environments. Instead, credit spreads are more suitable for more volatile trading conditions.
  • The wider the spread, the higher the exposure. If the difference between the strike prices of the options is higher, the trader is exposed to higher rewards at a higher risk.
  • Debit spreads are more directional trades than credit spreads as credit spreads usually rely on the premiums collected to produce a profit and not so much on the fluctuation of the underlying asset’s price.

Trade safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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2 Comments
  1. Johnny Ringo says:

    Bull Put Spread (2nd pgh) tupo … you say sell twice but it should be sell, should be sell and buy.

    1. Gavin says:

      Thanks, fixed.

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Options Trading 101 - The Ultimate Beginners Guide To Options

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